STRENGTHS

WEAKNESSES

Declining active population (low birth rate, emigration) and high rate of structural unemployment

Technological lag

Inadequate land links with the rest of the European Union

Wealth concentrated in the capital

60% of energy is imported, half from Russia

RISK ASSESSMENT

Activity sustained by consumption

Growth is expected to accelerate in 2016. The main driving force will still be household consumption (62% of GDP). This will continue to benefit from growing real disposable incomes as a result of the decline in the active population linked with emigration, as well as the rise in the minimum wage aimed at increasing the standard of living, which continues to lag behind the European average (income per capita by purchasing power parity equal to 64% of the European average). After three years of decline or standstill, a fragile upturn in investments is expected. Whilst agriculture and roads continue to receive European funding that has been effectively and quickly used, investments by companies, still deleveraging, are growing slowly in the face of uncertainties to the east and the weakness of the recovery in the west. Exports, in particular of food products (20% of exports), wood and derivatives (16%), telephones and screens are feeling the benefits of the favourable economic situation in their leading markets of Lithuania (19% of exports), Estonia (12%), Scandinavia (12%), Poland and Germany. The improvement, however, will be moderate. Exports to Russia (still 7% of exports in 2014, transhipping excluded), as well as towards other CIS countries (8%), could decline further as a result of Russian counter-sanctions and recession, as well as the depreciation of the rouble. Despite their redirection towards other markets, sales of dairy products, fish and beverages have been particularity hard-hit. In addition, because of the erratic operation of the only steel mill, Liepajas Metalurgs, imposed by the movement in steel prices, exports of steel products will remain irregular. International road and rail traffic, as well as warehousing utilisation, will depend on trade with Russia. As for tourism, the fall in the numbers of Russian tourists should be offset by the rise in visitors from other countries.

A satisfactory budgetary situation

The small public accounts deficit will remain. The increase in expenditure associated with internal and external security, as well as with social protection should be offset by the rise in receipts associated with higher growth, increased income tax progressivity and clampdowns on tax evasion linked with the shadow economy (24% of GDP). The level of public debt will go down again from its peak in 2016 linked with the early refinancing of a repayment scheduled for early 2017. Although largely held by non-residents, denominated in euros, there is no exchange rate risk.

Small current account deficit and significant non-resident bank deposits

The small current account deficit disguises a significant balance of goods deficit (9.4% of GDP). The low added value of exports increases their exposure to competition, whilst the limited diversification of national production favours imports. In addition, the lack of port facilities and land based infrastructure towards the rest of the European Union has slowed the geographic diversification of trade. External energy dependence is high, although Latvia could benefit from the new gas terminal in Lithuania and the two electric cables linking this country with Sweden and Poland. Nevertheless, the surplus in services, from tourism and goods transhipping (to and from Russia), European structural funds and remittances from ever larger numbers of workers abroad, help to offset most of this deficit. The balance is financed by foreign direct investment which has not suffered with the deterioration of trading relations with Russia. The gross external debt, whilst constantly shrinking, remains substantial (133% of GDP compared with 160% in 2010, but only 29% as net debt). One quarter is owed by the State, another quarter by non-financial companies. The other half is held by the banks. Whilst the level of local bank debt held with their Swedish parent companies is shrinking at the same time as local credit outstanding, deposits by non-residents, to a large extent Russian, are increasing, despite the worsening of relations between the two countries, and account for half of all deposits. These are concentrated with specialist banks which tend to invest these mostly in European and US gilts.

Ministerial instability and large Russian-speaking minority

The elections in October 2014 returned the traditional centre-right coalition of the Unity Party, the Alliance of Greens and Farmers and the National Alliance party, to power. It has 61 of the 100 parliamentary seats. There are however frequent disagreements between its members and ministerial instability, as illustrated by the resignation of Prime Minister Laumdota Straujuma resulting in the fall of the government in December 2015. The country’s biggest party is in the opposition. This is the centre-left Harmony party, which has 24 seats and is headed by the Mayor of Riga. It brings together the Russian-speaking population, 27% of the total, which is concentrated in the capital and in the poor Latgale region in the east of the country. It is unable to form a coalition because of the ethnic vote which was strengthened with the deterioration of relations with Russia.